Silver Thursday: How Two Wealthy Traders Cornered The Market

The stock market gets most of the media's attention because it's easier to grasp than its cousin, the commodities market. That said, the commodities market has as many spectacular stories to tell as the stock market. "Mr. Copper"- Japanese trader Yasuo Hamanaka - caught the world's attention in the 1990s when his daring (and brilliant) attempt to manipulate the copper market came to light. However, Mr. Copper was only building on a ploy pioneered by the Hunt brothers 20 years earlier. Let's take a trip through one of the largest speculative attempts to corner a market - and how it went awry. (For background reading, see The Copper King: An Empire Built On Manipulation.)Billionaire BrothersWhen oil tycoon H.L. Hunt died in 1974, he left his sprawling family billions. Two of his sons, Herbert and Nelson, took their oil money inheritance into the commodities market, investing in a way their father had never imagined. The Hunt brothers believed that inflation would result in silver becoming a haven, just like its more expensive cousin, gold.

Nelson "Bunker" Hunt, in particular, believed there would be inflationary pressures that would destroy the value of any investments denominated in or tied to paper currency. (For related reading, see Trading Gold And Silver Futures Contracts.)

A Demand Driven by TwoBunker foresaw at least a tenfold increase in the price of silver as a result of the plummeting real value of the dollar, so he and his brother began to buy up physical silver as well as future contracts. Instead of closing out contracts with cash settlements, a common procedure on the commodities market, the Hunts took delivery on silver. They then stockpiled this silver and used their large cash reserves to buy up even more futures. The billions in demand triggered the rise of silver to more than $50 per ounce. The silver bug siblings continued to take delivery and borrowed heavily to take out even more futures on silver once their immediate cash was all tied up. (Learn more about futures in our Futures Tutorial.)

A Name as Good as Gold$1 billion worth of silver purchases was bound to move the market, but the Hunts were able to amplify this jump by leveraging the family fortune many times over. The Hunt name was considered as good as gold where lending was concerned, and the Hunts were able to get capital at much lower rates than other speculators. They also preached their gospel of silver as the true haven in the upcoming inflationary flood to wealthy investors throughout the world and pooled converts' funds to buy up more silver and futures contracts. Some of the speculators helping the Hunts included Saudi investors - a fact that would become important when the U.S. started paying attention. (To learn more, read Why Leveraged Investments Sink And How They Can Recover.)

The SqueezeThe Hunt brothers had already considerably reduced the amount of silver available on the market and made their continuing buying action all the more powerful by pushing up the price of silver. In any commodities deal, there are longs and shorts, but in this case, the shorts were vastly overmatched. A short squeeze formed as the brothers continued to buy up available silver stocks and take delivery on their futures contracts. The Hunts' position was now worth around $4.5 billion. People were pawning coins and silverware to take advantage of the high price of silver, but there was less than a third of the silver market left that the Hunts did not control via futures. (For more on this strategy, read Short Squeeze The Last Drop Of Profit From Market Moves.)

Uncle Sam Steps InThe U.S. government became concerned over what it saw as a clear attempt at manipulating the nation's silver reserves, and the fact that this corner involved the Middle East added some venom to the government's reaction: after all, the 1970s oil crisis was still fresh in the nation's mind. Federal commodities regulators introduced special rules to prevent any more long position contracts from being written or sold for silver futures. This stopped the Hunts from increasing their positions by temporarily suspending the fundamental rules of the commodities market. With longs frozen and shorts free to pile in, the price of silver began to slide. Margin calls on the loans began to take a toll on the Hunts' reserves to the point where they were paying millions a day in calls, storage fees and interest.

Silver ThursdayThe Hunt name, however, kept them afloat with easy terms on more short-term capital. The Federal Reserve then took an unusual step: it strongly encouraged banks to stop making loans for speculative activity. When it became clear that the government was after the Hunts' scalps, their credit dried up. Concerns that the Hunts might not be able to meet margins with new loans and would go under (pulling several brokerages and banks with them), put further downward pressure on the price of silver. On March 27, 1980, the Hunt brothers finally missed a margin call and the market plunged; silver led the way, dropping to under $11 from its high of $48.70. (Learn about the margin call in our Margin Trading Tutorial.)

The AftermathGovernment officials considered a bailout to prevent systemic chaos. The action was vetoed, however, because the government agencies didn't want to be seen as underwriting dangerous financial speculation. In the end, the Hunt name held true, and the brothers arranged a private bailout from a consortium of banks and companies. The Hunts were dragged in front of Congress, scolded, charged with manipulation, fined, fined again and forced into bankruptcy. It took nearly a decade for them to unwind all their silver holdings and satisfy creditors, and the final bill left them billions poorer – although still wealthy by most standards.

The Sting of Irrational ExuberanceWhether they purposely intended to manipulate the market or not, the Hunts created a bubble in the silver market that severely shook the financial system. Whether stocks, silver, or sprawling suburban homes, too much "irrational exuberance" always comes back to bite the hand that feeds it.

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